China and Why Coal Prices Will Soar

In Beijing, I saw firsthand the unfolding boom serving China’s new and growing disposable incomes. Besides busy shops and restaurants and 5 million cars on the road in Beijing alone, there is something more basic that underlines all of this. In fact, it is more fundamental to the entire story of Asia’s new consumer.

It’s energy. Yes, all those factories require power. But so do iPods and air conditioners. So do cell phones and computers. The modern consumer economy is a plugged-in economy that eats electricity like locusts devour crop fields.

As a result, China has added power plants as fast as they can make ‘em. China adds more every day, accounting for about 80% of worldwide construction. The Economist reports that the capacity China adds in 2010 will exceed the entire installed base of Brazil. In the next two years, China will produce more power than the U.S.

Where does the power come from? About 80% of it comes from coal. Not just coal, but awe-inspiring amounts of the stuff. Consider that in 2000, China used about as much coal as the U.S. Here we are 10 years later, and China consumes three times as much as coal as the U.S.

There are a couple of problems with coal. One won’t surprise you, but one may. First, coal is a dirty fuel. You have to spend only a few days in Beijing or any of the big cities to see what burning so much coal does to the sky.

This creates many health problems in China, and the Chinese know this. Hence, there has been a lot of money flowing to alternative modes of power generation — like wind and nuclear.

The other problem with coal, which might surprise you, is that China may have hard time making more of it. This line of thinking comes from Richard Heinberg at the Post Carbon Institute.

As he points out, China is now burning some 3 billion tons of coal per year. In the last decade, it added 2 billion tons of production. That’s quite a feat. But as Heinberg points out, it gets much more difficult from here.

“Imagine building mining and transport infrastructure three times the size of the entire U.S. coal and rail industries in just 10 years,” Heinberg writes. “That’s what it will take for China to maintain 7% growth rates.” Heinberg calls his 7% assumption “conservative,” as China’s growth rates to date have been much higher.

Another limiting factor is water, of which the Chinese are already relatively poor. As Heinberg points out, “A typical 500-megawatt coal-fired power plant uses about 2.2 billion gallons of water each year to create steam for turning its turbines — enough water to support a city of 250,000 people.”

China will be pressed to produce the coal it needs domestically. In fact, after being self-sufficient in coal for years, China has begun to import coal. This year, it will import 150 metric tons, which is double last year’s total. It may seem a molehill compared with what it burns, but that molehill is about 60% of Australia’s coal exports — and Australia is the world’s largest coal exporter — and growing.

“This means if China imports double again next year — not an unrealistic scenario — China will need to import more coal than Australia can currently provide,” Heinberg notes. “One more doubling of import demand and China will be wanting to import 600 million tons per year, about the total amount of coal exported by all exporting nations last year.”

This is fairly astounding math. And the first thing it makes me want to do is buy coal. It doesn’t take a lot of brains to see that if this kind of demand scenario unfolds, it is going to drive up the price of coal everywhere.

And as coal is still the primary means of generating power in the world, it’s going to have ripple effects throughout the energy chain. Natural gas-fired plants, for instance, will look increasingly valuable, especially as natural gas prices continue to wallow in the mud.

Another idea is to look at the engineering and construction firms (E&Cs). The E&Cs are in the business of building the hardware you need to process and produce energy. They build coal-fired and nuclear plants. They build refineries and liquefied natural gas (LNG) terminals and biomass boilers. If you need more energy, you need an E&C.

E&Cs rise and fall with spending on energy projects. As oil demand (and pricing) has recovered in 2008 and 2009, this sets up strong capital spending for the next several years. This idea is particularly timely, because the market has knocked down one of the leading E&C firms by 25% in just the last month. It’s a compelling value, as you’ll see in today’s market.

About Chris Mayer:

Chris Mayer is a financial analyst with Bonner & Partners. He has been quoted many times by MarketWatch and has been a guest on Forbes on Fox, Fox Business and CNN Radio, and has made multiple CNBC and radio appearances. He’s also contributed to The Washington Post. Chris travels the world looking for great ideas and insights for his readers.